:max_bytes(150000):strip_icc():format(jpeg)/cropped-image-of-man-checking-stock-market-on-mobile-phone-1051266664-4a15595ada4446c290de32cd866e71bd.jpg)
Many traders spend a good portion of time looking for and identifying trends in stock charts, hoping to ride the next wave to profit. However, for some, sideways price action can be just as lucrative. When a security stops following a trend and instead oscillates between two prices, it becomes range-bound.
As the price bounces back and forth, it establishes identical, or nearly identical, highs and lows, creating an upper resistance level and a lower support level. While the limited upside potential may be frustrating for someone looking to ride a trend, the relative predictability of these highs and lows can mean easy money, albeit in smaller quantities.
Key Takeaways
- Identify Range-Bound Securities. A security is considered range-bound when its price moves consistently between an upper resistance level and a lower support level without breaking these bounds. Recognizing this pattern is crucial for implementing a range-bound trading strategy.
- Price Channel Strategy. Once a range is established, traders can potentially profit by buying near the support level and selling near the resistance level. Options trading strategies, like buying calls near support and puts near resistance, can also be effective.
- Risk of Breakouts. One major risk in trading range-bound securities is a price breakout. This occurs when the price moves beyond the established range, either up or down, potentially nullifying prior trades based on the range.
- Using Indicators Wisely. Pay attention to indicators like trading volume, as they can signal an impending breakout and help traders adjust their strategies accordingly. A knowledgeable approach can allow traders to benefit from both the range and potential breakout.
Mastering Range-Bound Trading Techniques
To effectively trade a range-bound security, it is essential to first confirm the range. This means the price should have reached at least two similar highs and lows without breaking above or below at any point in between.
Once the range, or price channel, is established, the simplest trading strategy is to buy near the support level and sell near the resistance. Alternatively, when trading options, one could purchase calls near support, and purchase puts near resistance. To illustrate, say a stock’s defined range is $5 to $10. This would mean support is at $5, and resistance is at $10. By purchasing a call near the support level at $5, the trader can profit when the stock rebounds to $10. The flip side would be to purchase a put near the $10 resistance level, and secure a profit when the stock price drops to $5.
Since the chief risk inherent in trading range-bound stocks is being on the wrong side of the breakout, it is important to pay close attention to any clues that might hint at when it will occur. Generally, a trading range is merely a pause before the continuation of a current trend or a period of indecision in the market before opposition forces a reversal.
Therefore, while it is tempting to simply set a stop-limit order near the support or resistance levels and trust the pattern, it is crucial to pay attention to other indicators, such as trading volume, that may indicate an impending breakout. If the price breaks downward through the support level, a prematurely purchased call can quickly be rendered worthless. A patient and conscientious trader can profit from the range and the breakout.
Fast Fact
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future performance. Investing involves risk, including the possible loss of principal.
